A sword that cut both ways

MBS brought homes to masses, but also increased risk for banks

Dennis Neubert is the owner of Planet Financial a business that primarily deals with buying and servicing mortgage loans. A year ago the company moved from Hoffman Estates to Algonquin.

It wasn't that long ago when families saved much of their lives to afford a down payment on their home.

Not their first home. Their only home.

It was a time when mortgages were issued through conservative lenders and savings and loan branches that were set up to make funding available to potential homeowners.

"If we go back to an S&L kind of structure, the mortgage market was limited by the deposit base the lender had available," said Dennis Neubert, president and CEO of Planet Financial Group in Algonquin. "If you didn't have an adequate number of deposits [you couldn't make loans], you could only lend what they had in deposits."

That changed when a secondary market was created in the 1970s, allowing mortgage loans to be grouped, sold, and turned into securities.

Securities can be any item with a value that can be traded, including stocks, Treasury bonds, preferred shares or options. Because these securities were tied to mortgages, they were called mortgage-backed securities, or MBS.

Now, mortgage lenders are able to recover their initial investment and use it multiple times to make home loans available to more people.

"It allowed that lender to lever that mortgage origination by getting their initial investment of deposits back by offering the mortgage to the bond market, and having a bond investor give them the money back," Neubert said.

Say a local bank writes a $150,000 mortgage loan. After the mortgage is signed, the lender goes to a bundling agent – who is collecting loans for a mortgage-backed security – and sells the loan to the agent or directly to the agencies.

The lender gets some of its original $150,000 back in the deal, and can use it to make another home loan.

Say the loan was sold for $150,000 – or more. The next time the lender wants to write a $150,000 mortgage, it has all that money back in its deposits – and potentially even more.

"You could lend that single amount of money over and over and over," Neubert said. "Fannie [Mae] and Freddie [Mac] came about as a market expansion tool to expand the size, scope and capability of the mortgage market."

Although the secondary housing market had been around since Fannie Mae was founded in 1938, the mortgage-backed security market beceame the driving force in the housing boom nationally, and locally, with the expansion of Fannie Mae's portfolio under the Bush and Clinton administrations in the 1990s.

In 2001, McHenry County posted 5,384 home sales. At the height of the housing market in 2005, that total rose to 6,309. Last year, after the crash and the government takeover of Fannie and Freddie, the county registered 2,813 sales.

"The secondary markets came along to enhance the volume and expand those mortgages greater than the deposit base allowed," Neubert said. "Today, [the private secondary market] doesn't exist anymore. Without the secondary market, we don't have a housing-specific tool, no special incentive for financial institutions to provide for the markets.

"If you look at real estate today, we certainly haven't regained our strength because there's no private securitization market available. And because Fannie and Freddie are the only securitization, it's a very restrictive market."

Fannie and Freddie were taken over by the government in 2008 to avoid collapse. To date, the agencies have received $168.5 billion in taxpayer funds to stay afloat, $103.8 billion of it to Fannie Mae. Still, Neubert said, their presence is needed.

"The housing finance markets would be incredibly impacted [if Fannie and Freddie were shut down]," he said. "It would be much more difficult to get a loan."